qandaQ: Should a retiree invest in small cap and emerging markets?

Q: As a retiree I am uncomfortable with funds that invest in small companies, as well as emerging markets. Should a retiree be taking that kind of risk? 

A: I think the first step is to determine how much of a portfolio should be in any kind of equity asset class. It turns out the intermediate-term risk of a portfolio comprised of large, small, value, growth, U.S. and international asset classes has about the same downside risk as the higher quality S&P 500.  So, if you have the risk tolerance of 50% equities, the downside risk of the portfolio is about the same with or without the inclusion of small cap and emerging market funds. Yes, there will be slightly larger short-term losses with the addition of the more risky asset classes, but these asset classes also rebound much faster when the market turns around.

 The important consideration is that by adding the more profitable asset classes, the returns are likely to be substantially higher. That allows an investor to have more fixed income in the portfolio to meet their goals, thereby reducing their overall risk. Over the last 45 years a 70% worldwide equity/30% fixed income portfolio has about the same return as a 100% S&P 500 or total market index, at one-third less risk.